Archive for Supply Management

The old maxim, “Divide and conquer” has been the successful strategy of war lords over the centuries. The same applies today in business and a prime example of how to devalue a national business model; destroy an industry and put thousands of small business “to the sword” was the result of the abolition of the UK Milk Marketing Boards in October 1994.

Almost twenty years ago, UK producers were receiving the same price as today, 24pence-per-litre (ppl) and the industry was on an upward trend. Farmers were making a profit and this in turn allowed reinvestment, expansion and modernisation of plant and equipment. Over the past year, milk prices have dropped from 34ppl to 24ppl and below. Costs have increased for feed, labour and equipment and loans were secured on the premise of a viable return on investment.

As every dairy producer knows, stability is the key to a business model that depends on a long-term investment, requiring a three year lead-in before a unit of production (a cow) starts to repay the investment on her semen and rearing costs. The old adage that it takes three lactations for an animal to pay for her replacement (under “normal” business financial situations it takes all the profit from two lactations – that is why genetics is important) takes a “hit” as milk prices tumble due to market volatility.

Milk Marketing Board

UK dairy farming in the 1930s was extremely volatile as producers loaded milk churns on to trains without the assurance of being paid. Many producers did not receive payment, due to an unscrupulous system and if the milk was not needed, it was sent back. Farmers were at the mercy of the individual dairies. In order to establish a fair and coherent system, the British Government established the Milk Marketing Board (MMB) system for England and Wales as well as, separate Boards for Scotland and Northern Ireland.

The 1933 government statute changed the fortunes of dairy farming. The MMB effectively became the first buyer of milk; but most importantly, became the buyer of last resort. The establishment of the Board guaranteed a minimum price for the dairy farmer, based on agreed price formulae. The system provided stability – in an unstable world – and the Board was heralded as the greatest commercial enterprise ever launched by British farmers.

The system proved successful and capable of withstanding the instability of the markets. The collective strength (remember: divide and conquer) provided a negotiation position and a pricing system that secured the liquid market price – from the instability of milk sold for manufacture. And the Board therefore provided a system of dealing with an extremely perishable product; especially in the days before refrigeration.

Parliamentary Business: House of Commons report. “The MMBs were established to resist downward pressure on producer incomes resulting from the increasing power of the dairy companies.”

The power of the MMB increased over the decades and employed over 7,000 people across its various sections including the establishment of an AI industry off-shoot, which subsequently evolved into Genus. However, the Board system had its detractors and although far from perfect, was seen by its critics at the time, as being monolithic, out of touch with the modern business world and the MMB being self-sustaining in terms of its own interests.

The Thatcher Years

There is an old saying, “If it isn’t broke- don’t fix it.” However, EU dogma and political ideology reared its ugly head as Thatcher doctrine decided that the system that had served the industry well for 60 years; should be abolished. The mantra of “deregulation” and privatisation was part of the Thatcher Government ideology.

Milk producers did not agreed with the political ideology and voted 99.9% to maintain the MMB system. Despite the overwhelming vote, Thatcher abolished the MMB in October 1994 in England, Wales and Scotland and in Northern Ireland in February 1995. As a result, thousands of dairy farmers were subsequently ruined and this in turn created the rise of division; and supermarket power.

At the time of the abolition of the MMB, there was an estimated 30,000 producers in England and Wales. Fast forward 20 years, and that figure is 10,000 or less. In December 2014, an estimated 16 dairy farmers per week were leaving the industry. For some, enough was enough.

UK PRICE CUTS

Farmers supplying Arla, one of the UK and Europe’s largest food retailers, suffered a reduction of 1.63ppl for December 2014 milk production. Arla suppliers subsequently received a generous early Christmas present on December 23rd with the further announcement of a 2.03ppl reduction effective, 5th January 2015. The timing was perfect and some cynics would consider deliberate, with the announcement aimed at limiting producer hostility and adverse press reaction over the Christmas recess.

Another UK and European retail giant, Muller, cut its price by 1.2ppl from 10th January and Dairy Crest, the UK milk processor, announced a 1.2ppl reduction from 1st February. In a game of milk price-cut poker, First Milk, a 100% UK farmer-owned cooperative played its New Year double-hand, by announcing a milk price of 20p-per-litre from February 2015; cutting 1.6ppl to 20.1ppl for liquid pool supply, and 2.43p reduction to 20.47ppl for manufacturing.

A few days later, First Milk declared it was delaying milk cheque payments to producers by a further two weeks – the delay expecting to cause further producer chaos. The company cited a cash-flow problem for the delay albeit farmers suffering more financial pain. First Milk suppliers have incurred a minimum 12ppl drop in ten months from April 2014.

After 80 years, UK dairy farmers are once again at the mercy of dairies, processors and the supermarkets; the latter discounting milk as a “loss-leader” in order to entice consumers into their shopping aisles. The ongoing supermarket price war continues to undermine the dairy industry rather than underpin its stability, structure and long-term future.

The MMB pricing structure provided a simple solution to milk pricing and included increases for milk quality and hygiene. The dilemma facing farmers today is confounded by having approximately 50 different milk price payment structures and tied-in contracts to their buyers. Furthermore, if a farmer leaves his current buyer; there is no guarantee another buyer will purchase the milk.

According to official UK Government sources (Defra) post deregulation: “There are 130 milk purchasers and 100 processors. 65% of household consumption of liquid milk and 80% of dairy products are sold primarily through the major supermarkets.”

RETURN TO THE “BAD OLD DAYS”

Many farmers considered the “bad old days” of the 1930s had long surpassed but that has not been the case. Volatility returned in 2012, when Rock Dairies went into administration leaving 22 regional milk producers without an outlet for their future daily production. The business had supplied thousands of shops, super-markets and businesses throughout the north of England.

Rock Dairies financial collapse caused a furore amongst its former suppliers that were left without payment for milk produced in January and February 2012. Today, the furore extends to thousands of milk producers who are suffering a collapse in prices without a positive end in sight.

Like many, Michael Howie from the award winning Morwick herd in Northumberland, England, is currently receiving a January milk price of 24.9ppl – well below the cost of winter production. Twenty years on from deregulation he says, “None of this would have happened if the MMB had remained functional. We no longer have a safety-net. There is too much milk being produced – and quotas are set to be abolished in April 2015.”

The UK has produced 10% more milk over the past year and this has not helped the situation. Although the UK remains 80% self-sufficient in milk production, the dairies blame the global-market for the price decline. The old “supply and demand” rule of economics has reared its ugly head with devastating consequences. China, the world’s largest importer of milk reduced imports by over 50% in the first six months of 2014.

Russia, the third largest importer banned dairy imports from the EU in August 2014 in retaliation for the sanctions imposed by the EU following Russian involvement in the Ukraine and Crimea. UK dairy farmers are clearly facing tough challenges according to Andrew Suddes, Senior Consultant with Promar International.

In an exclusive interview for The Bullvine, he said: “Promar expect this trend to continue into autumn 2015. In addition, the Russian ban on imported dairy products is due to end in August 2015 and this may release some of the pressure in the market. Dairy farmers currently face prices that are below the cost of production and long-term, this is unsustainable. The situation will have an inevitable impact on farm businesses and associated supply industries.”

However, Mr Suddes advises farmers to plan ahead. “Farm businesses need to plan carefully to manage in the short and medium term. This will involve a detailed understanding of their cost structure and potentially, a proposal to their business bankers. So far, banks have expressed sympathy with businesses in the dairy sector, but producers will require a detailed and coherent plan to get through what will inevitably be a testing period,” he states.

ECONOMIES OF SCALE

During the past 20 years, due to quotas and the MMB being abolished, the number of milk producers in England and Wales has declined by over two-thirds; although due to herd expansion, cow numbers have remained fairly stable. This global trend is set to continue – although those dairy farmers that have recently increased herd size and invested in the long-term future, face severe challenges.

Businesses will encounter, possibly for the first time in a generation, increasing losses due to economies of scale. Huge investment and large-scale expansion coupled with calls for greater levels of efficiency; have therefore perpetuated small profits on a pence-per-litre basis multiplied by volume production; and became the de-facto business model. The reverse has happened with ever increasing pence-per-litre losses multiplied by large volumes of production.

Several UK producers, who voluntarily terminated their supply contracts during 2014 with their existing dairies, at a time when the milk price dropped from 34ppl to 28ppl, have subsequently not found a new “home” for their milk with alternate dairy companies. These farmers are currently receiving 20ppl on the “spot” market with some producers rumoured to be receiving spot prices of 16ppl.

Political ideology is legitimised by actions of the state; and in a democratic world the wishes of 99.9% of UK farmers not to abolish the MMB system would, and should have, prevailed. Canada currently provides domestic food security, consumer price affordability and milk production business investment, through its provincial Milk Boards and Federal Regulation supply management system.

Inevitably, one day – calls and policies will be aired regarding the dismantling of a system, considered by some within the production community as well as, international exporters of dairy products, as being far from perfect, but a system that provides – and balances, price stability and market supply – within an unstable global marketplace.

There are many lessons to be learned for milk producers around the world from what is occurring in the UK. Within Canada, such dissension will lead to yet another “Divide and conquer” scenario. Beware: “The enemy is at the farm gate” as well as, from within.

Here is a quick science lesson for everyone. It isn’t going to be like those boring chemistry classes in high school, where you were more excited about getting to use the Bunsen burner than actually learning something. This is a political science lesson about international politics. When it comes to world trade, Oil is far greater and more important to most countries than milk production is.

Recently there has been a great deal of talk about the removal of supply management from markets around the world. Since most of Europe has either already removed supply management or is in the process of doing so, the writing is on the wall for remaining supply managed countries such as Canada. It’s no wonder that there has been significant backlash from Canadian producers about this issue.

Understandably Canadian dairy producers are very uneasy with this proposition. They have enjoyed a stable production environment where they could go to bed without having to worry about what the milk price would be the next day, next week or next month. But all this is about to change. As the Canadian government seeks to open world markets through international trade, Canada’s supply management is a constant sticking point. (Read more: Why the Future of the North American Dairy Industry Depends On Supply And Demand)

Interestingly, and probably funded by those who seek to benefit the most, recent reports from the Conference Board of Canada suggest that the cost of ending milk quota is far less than expected. (Read more: Cost of Ending Quota Much Smaller than Expected). According to the study, the Canadian Government could buy out producers who hold quota, about 12,500 dairy farms, for as little as $3.6 Billion to $4.7 Billion.

Armed with this study over the past month, there has been significant media hype in the major publications about how this is “Good for Farmers.” The news flash is that the Canadian economy would gain $1.2-billion a year and as many as 8,000 new dairy jobs, if the industry were freed to pursue rapidly expanding dairy markets in Asia and Africa. The story angle is that Canada is losing ground by doing nothing. The study estimates that Canadian dairy farmers are sacrificing $1-billion a year in lost revenue as milk is being displaced by cheaper imported dairy ingredients and substitutions by oil-based products in everything from ice cream to yogurt. (Read more: Canadian dairy producers can grow without monopoly and Dairy supply management costs consumers and farmers)

First let’s get real. Most Canadian dairy producers are not in the position to compete with world markets. This is e true if you remove quota and don’t replace it with the other forms of unacknowledged subsidies that other dairy producing countries maintain. As a result of operating under the safe and secure quota system, many Canadian producers have not been forced to become as efficient as those in other markets such as the Western US, Australia and New Zealand. In 1980, Canada produced 14 per cent more milk per capita than the U.S. In 2011, Canada produced 21 per cent less. The average Canadian dairy farm has about 76 cows while the average herd in the US is 187. (Read more: Where have all the dairy farmers gone? In Depth Analysis of the 2013 U.S. and Canadian National Dairy Herd Statistics). In order to compete, Canadian dairy farms would not only have to grow but they also would have to manage their operations differently.

But the real issue here is not about what effect this will have on dairy farmers. It is about what market it opens up for other industries, specifically Oil and Pulp and Paper. Due to the massive investments in the Oil/Tar Sands in Northern Alberta, Canada has become a significant player in the world oil market. The potential revenues from these developments make the cost of removing the Canadian Supply Management System look like a drop in the bucket.

The Bullvine Bottom Line

The amount of money, especially political funding and taxes, that this Oil movement has behind it is far greater that any backlash that would result from removing supply management from the Dairy industry. For the average producer, there is no question that the removal of Supply Management is a BAD thing. There is no question that it will force many 50+ year old producers into early retirement. Now that could be something that would cause strains on the Health Care system because a displaced dairy farmer does not do well mentally or physically. It will also force any new young producers to be very afraid to enter the market. You see, faced with a volatile sales price, milk production will become an uncertain career choice. So let’s not kid ourselves. The question of removing supply management from the Canadian dairy industry has nothing to do with what’s “best for the producers”. Removing supply management is totally about what’s best for the Canadian economy as a whole and significant industries such as Oil in particular. For all Canadian milk producers who have the deluded notion that their concerns are enough to stop the Canadian government, never forget that “Oil is thicker than Milk.”

When it comes to supply management, many proclaim to know the absolute truth. They either profess “It will never be sold out.” or they’re emphatically on the other side stating “Supply Management is dead!” (Read more: Why the Future of the North American Dairy Industry Depends On Supply and Demand) Unless you can read the minds of the politicians (and even The Bullvine won’t pretend to go that far), you are putting your future in someone else’s hands.

Come Out Come Out Wherever You Are!

The issue of supply management raised its head in the late 60s. Many think that once implemented that’s all there was to it! WRONG. In 1976 the MSQ was decreased by 18% in response to a serious surplus of production. RIGHT MOVE. Then later on the word was out that Supply Management was coming to an end. Some prepared instantly. WRONG. Today many aging dairy farmers want to retire … but their children are not sure whether the “security” their parents had is going to continue. Others worry that a closed off dairy industry will be unable to provide the opportunities they’re looking for.

In the Beginning

Supply-management was introduced by the federal government in the 1970s as a way to ensure local farmers could meet domestic demand and be rewarded fairly for their effort. The introduction of quota levels helped to control supply while creating stable prices for Canadian consumers. Prices for milk worldwide had led to fluctuating prices and instability in Canadian markets. The government sought to fix this by implementing a system to provide milk and poultry for the Canadian market by Canadian producers.

Is Government the Game Changer?

Why do we modern day business people never ask ourselves what our parents did to adapt to change? Unlike them – we accept that their solution is “forever”. At a certain age somewhere between 40 and 65, we assume that we have done all that there is to do and the way things are right now is the way they should remain…. full STOP. But that’s just the problem. Why would the next generation want to come into an industry that is fully stopped?

But back to the issue of supply management. What if— supply management ends in the next 5 to 10 years? What if supply management stays? How will your children continue dairying? Oh! They’re not interested you say. Well then how will the next generation of dairy farmers get interested in getting into the industry? We know it’s an awfully expensive entry price. And, if we keep the status quo, the industry is shrinking from both ends of the marketplace. Less consumption. Fewer producers. What’s the game changer that we MUST find?

Is Everybody Playing Fair?

Canada`s milk supply management is increasingly a hot button issue when it comes to trade negotiations. Many quote rules of fair trade that exclude supply management never acknowledging that there are hidden subsidies supported by other players in other countries. Subsidies accounted for only 14% of gross farm receipts (2011) in Canada. Considerably less than the 19 per cent average of among OECD countries. This raises the question of what would happen if in the interest of big picture trade negotiations Canadian officials eliminate farm marketing boards and subsidies while other countries were able to keep subsidizing their farmers? In Japan, South Korea, Norway and Switzerland that means more than half of what farmers earn is from government support. Yes! Over 50%!!

Are Governments Changing the Playing Field?

Everyone loves to throw the term “level playing field” into the discussion. But is it really possible? After all can you name any industry that isn’t subsidized? And secondly, is a level field really what you want when it involves food production. After all, without food we die. That’s more level than I’m looking for!

True Lies

The theory is that if supply management was terminated, larger more efficient farms would readily compete against cheaper imports. Really? And who is prepared to deal with how “larger” farms will rile up the anti-large contingent? But consumer prices will be lower and that makes it all worth it, right? WRONG. The cost comparison between supply management and the market-determined price is like comparing apples and oranges. When the market sets the price, the direct expense to consumers does not generally reflect the outlays incurred by the farmer. As a result, government must provide billions of dollars worth of subsides annually to farmers if they are to stay in business. The critics of supply management do not factor these hidden taxpayer dollars into the cost of a litre of milk, no matter how critical that support may be to its production.

Is Free Trade Fair Trade?

Economists Jason Clemens and Alana Wilson of the Fraser Institute unfortunately get it wrong in their assessment of Canada’s supply-management system for dairy products in their May 15 column: “Free market for groceries is better for the poor”. Where is their proof that there is suddenly a lower retail price without supply management? A real example is the experience in New Zealand. They once had supply-management before switching to a free-market situation in the mid-1980s. Surprisingly, to some, prices increased for consumers and a monopoly was established where one dairy controls 90 per cent of the milk farms. A parliamentary investigation has been undertaken to determine why prices increased. Milk is known there as white gold.

It’s Better for the Consumer

Opponents claim that supply management gouges consumers at least when compared with prices set by “the market”. They talk glowingly about free trade and the positive impact of open markets on industry. Where do they look when there are market meltdowns, rising unemployment and natural catastrophes? It’s obviously their choice to turn a blind eye to the crutch provided by governments in these “healthy” economies. Even if we could accept the global marketplace who decides the priority markets when drought devastates the food supply of your global partner? I suspect that the home market would be highest on the list.

Who (or What) is Hiding?

There are certainly a considerable number of issues with the Canadian food system. Surface comparisons would suggest that food is much cheaper in the States. Closer to reality, is the fact that there are 300 million more people to share the cost of subsidizing the industry. Ron Versteeg of Dairy Farmers of Canada says Canadians have nothing to hide. “We stand alone in providing, clean, consistent and transparent access to our market, while other countries hide behind phony non-tariff barriers.” There is no hidden subsidy provided by Canadian taxpayers to dairy farmers. Each time consumers buy milk or cheese they contribute to dairy sustainability and resilience, to say nothing of this country’s food security. By comparison, U.S. Subsides to dairy producers represent about 40 per cent of American dairy farmer incomes, when it reaches them. These subsidies come directly from taxpayers’ pockets. At the store, the U.S. consumer pays only a portion of the overall cost of producing milk. The rest is paid through their taxes. Without that hidden support, American dairy products would be much more costly for consumers, and much more expensive than the equivalent Canadian product.

But You Can’t Get Into the Game!

The quota value for a small forty cow operations is over $1 million. Barrie McKenna, columnist with the Globe and Mail, suggests decline in farms is directly related to barrier of entrance in the industry. Making it impossible for young farmers to finance that in addition to cattle, land, barns and equipment. Supporters of supply-management argue the high quota shows that the industry is healthy and, like other profitable businesses, dairying require high start-up costs, similar to purchasing franchise fees to begin operations. There are many other non-agricultural businesses that no longer have “mom and pop” operations. Decreasing economies of scale make it difficult for small businesses to compete; this decline in numbers extends beyond the dairy industry. Having said that, just because the problem is difficult does not mean that we should give up.

The BULLVINE BOTTOM LINE “Nowhere to Hide!”

You can hide in the bushes and hope that it will all turn out right in the end. But wouldn’t you rather be “It!” In the past successful builders of the dairy industry did not wait for the dreaded pronouncement “You must be caught!” Supply management was their solution. What is ours?

With the recent announcements about both Canada and the US entering significant trade negotiations with the European Union (EU), there has been a great deal of discussion by breeders on both sides of the border about what this means to the future of the North American Dairy Industry (Read more: A Nation Held Hostage By Dairy Cows and Dairy Groups Welcome Launch of U.S.-EU Negotiations). One thing I learned in my microeconomics class is that in any competitive marketplace the price is determined by supply and demand. As we enter into a more competitive global marketplace there is no question that the dairy industry will depend on this economic model to determine its future.

The Future of Supply Management

It’s really pretty simple. In any industry you need a buyer and a seller. If you have more buyers (demand) than you do sellers (supply) the price goes up. If you have more sellers than you do buyers then price goes down. Well, unless you are in Canada, where there is supply management and then that is a completely different story. In Canada the 12,700 dairy farms have been protected from this economic model because of the supply management system. It blocks foreign competition from coming into Canada by placing elevated tariffs on milk and milk products thus making it impossible for imports to compete. Only about 5% of the Canadian dairy marketplace is supplied by imported products. It has also controlled the level of production domestically (Quota) so that there is not an oversupply in the marketplace. This protects the price of milk so that dairy producers in Canada have been able to enjoy a stable milk price and consistent predictable revenue.

The challenge with this is that the world is very quickly moving to a global marketplace. In addition, one of the global requirements is that there is “fair” and equal trade in all industries. This means that systems like supply management are being removed in many countries and certainly are key issues in international trade negotiations. Many Canadian producers have millions of dollars tied up in quota. Compare this to the $12 billion a year trade negotiations Canada is having with the EU and you can see why there is concern about the future of supply management. While I totally can see the benefits to Canadian farmers from the system, you simply cannot deny the benefits of world trade to the whole country. Hence you can see why these programs are severely at risk.

Canadian dairy farmers simply need to look south of the border to see what life without supply management is like. Dairy operations have to operate very differently when sale price and production is not set by a managed system. There you are forced to run your farm more like a corporate organization, with detailed analysis of profit and loss and all decisions dependent on the effect it will have on the bottom line instead of on emotion. Yes it makes dairy farming more of a business than a way of life, but that is the future. The other is the past.

It also means that the marketplace will determine who stays in business and who goes under. If there is an over production of milk, milk price will go down. Those organizations that are having challenges will go under. It’s simple business. Run a good business you will succeed. Run a poor business and you will fail. Notice how I said business and not farm. Dairy farmers have to start looking at things differently. Dairy farmers need to be business persons first and farmers second. This could be a change that many farmers are not able to make.

Demand the Other Side of the Equation

The second part that I learned in my long and boring microeconomics class is that if you want to increase milk price and cannot decrease supply, then you need to increase demand. According to estimates, the world population is set to reach 9.3 billion by 2100. Much of this growth is set to come from countries like China, South America and Africa. Very impressive numbers for sure, but let’s look at milk consumption in those regions. China averages 28.7 kg/capita/year, most African countries average less than 50 kg/capita/year, and most South American countries average around 100 kg/capita/year. That is nowhere near the 253.8 kg/capita/year that Americans consume, 206.83 kg/capita/year for Canadians and over 225 kg/capita/year for most EU countries.

Therefore, if population growth alone is not going to help significantly increase demand for dairy products, we then need to look at how milk and dairy products compete for market share. As we highlighted in our recent article, Milk Marketing: How “Got Milk?” became “Got Lost”, the land of milk and money is gone. As an industry we forgot about the consumer, we forgot about the product, and we forgot how to innovate!

A simple trip to the local grocery store reveals that while products like organic foods, international foods and soft drinks are always innovating and battling for market share. Milk, for the most part, has not done anything. Look at these pictures that show the amount of shelf space (key in driving sales) these other products have compared to milk. We can no longer rest on our milk stools. We have to compete for the marketplace with all the old beverages … and countless innovative new ones. That may seem to be a daunting task but it can no longer be ignored!

The Bullvine Bottom Line

The world is changing, old systems and production models are being eliminated and new ones are being established daily. Those that sit and try to battle to keep the old will be left behind. We need to look to the future instead of fighting for the past. Consumer demand is the most serious issue impacting the future of the dairy industry. We need to understand what the consumer wants instead of fighting for what we used to have. If you want to be part of the future, think about SUPPLY and DEMAND. There are good reasons why it is NOT called The Law of Supply and PROTECT!!